Financial Industry Insights from Advisors Asset Management

Earnings Cliff?

We are now about 63% (316 of the 500 S&P 500 companies have reported) of the way into the third quarter earnings season and the popular opinion seems to be that the earnings are disappointing, that this current earnings cycle has peaked and that earnings going forward will fall sharply (earnings cliff). In a nutshell, we don’t believe that this is the case and will begin with the former, that the current crop of earnings reports are disappointing.

Clearly, there have been some high-profile earnings misses this quarter, such as Google and Apple – and of course there is the fact that Google even mistakenly released their earnings report midway through the trading day on Oct 18 vice after the close of trading. Despite this, as we look at the numbers, we see a current earnings season that looks, at least statistically, very similar to the last and also compares very closely with long-term averages.

The table below summarizes for the current quarter and last quarter (with a similar amount of companies reporting), four different statistics that we track to help us analyze earnings.

Period

Last Quarter

Current Quarter

Number of reports

312

316

Percentage with an upside EPS surprise

72.44%

72.06%

Percentage with an upside revenue surprise

40.19%

40.13%

Percentage with year-over-year EPS growth

66.67%

61.15%

Percentage with year-over-year revenue growth

60.90%

60.19%

Source: Bloomberg

As you can see, the current quarter statistics are all almost identical to last quarter with the exception of year-over-year earnings per share (EPS) growth which is trailing by over five percentage points. However, the amount of year-over-year EPS growth (not in table) is actually ahead this quarter when compared to last quarter by 0.21%. In addition, when looking at EPS surprise, we see a very slight decrease this quarter when compared to last, but both numbers compare favorably to the long-term average of 71.92% and it should be noted that the amount of surprise has gone up from 3.82% last quarter to 4.73% for this current quarter. Thus fewer companies are beating EPS estimates this quarter than last, but the ones that are beating it are doing so by a wider margin. Given all of this, we don’t think if investors or commentators really look at the numbers they can classify this earnings season as a big disappointment. However, perhaps they aren’t looking at the numbers but utilizing more of a qualitative approach, which focuses on what the companies are saying.

It has been our experience that since the Securities Exchange Commission (SEC) adopted Regulation FD (Fair Disclosure) in August 2000 that many corporations have adopted a more conservative approach when discussing the future, especially when major events are around the corner, such as the imminent presidential election and the looming “fiscal cliff.” Given this, we can understand why many corporations would state things look fuzzy or challenging or even murky going forward. Clearly it is much better to under promise and over deliver vice the opposite. That being said, the economic data coming in over the last month indicates to us that we will not be falling off an economic or earnings cliff any time soon and earnings will most likely stabilize and could even accelerate again in the near future. This recent economic data includes better than expected levels for both the ISM Manufacturing (back above 50 again) and Non-Manufacturing Indices, The Leading Indicators Index, vehicle sales, retail sales, housing starts, home prices, both existing and new home sales and third quarter GDP. As we have stated before, we don’t believe the U.S. economy is set to impress, but it does look as though it will continue to grow, driven by a strong U.S. as well as Emerging Market consumer (looks like China’s economy may have bottomed at 7.4% GDP growth last quarter), a housing and vehicle recovery in the United States, as well as the move toward the United States becoming energy independent. In addition, don’t forget the record amount of cash that U.S. corporations have been holding on to as they await some clarity to what will occur in Washington, D.C. We believe these forces should keep earnings from falling off of a cliff and continue to drive this bull market to even higher ground into 2013 regardless of which presidential candidate wins the election.

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